Federal Court Disapproves Proposed Settlement of SEC Enforcement Action Against Bank of America

A federal judge has disapproved the proposed consent settlement of an SEC enforcement action against Bank of America upon finding that the settlement was neither fair, nor reasonable, nor adequate. It was not fair because it did not comport with the most elemental notions of justice and morality in that it proposed that the shareholders who were the victim’s of the bank’s alleged misconduct now pay the penalty for that misconduct. It was inadequate because the injunctive relief is pointless and $33 million is a trivial penalty for a false statement that materially infected a multi-billion-dollar merger. Finally, the court emphasized that a proposal asking the victims to pay a fine for their having been victimized is unreasonable. SEC v. Bank of America, SD NY, 09 Civ. 6829.

The SEC charged the bank with making materially false statements in a joint proxy statement that it filed with Merrill Lynch & Co., Inc. in connection with the bank’s $50 billion acquisition of Merrill Lynch. Among other things, the SEC said that the bank falsely represented to both its own shareholders and to the Merrill Lynch shareholders that Merrill had agreed not to pay year-end bonuses to the firm’s executives when, in fact, the bank had agreed that Merrill could pay such bonuses up to as much as $5.8 billion.

While very mindful of the considerable deference owed to the parties’ proposed settlement, the court noted that, when a federal agency seeks to prospectively invoke the court’s own contempt power by having the judicial imposition of injunctive prohibitions against the defendant, the resolution has aspects of a judicial decree and the court is therefore obliged to review the proposed settlement more closely to ascertain whether it is within the bounds of fairness, reasonableness, and adequacy and, in certain circumstances, whether it serves the public interest.

The hypothesis that a corporate penalty sends a strong signal to shareholders that unsatisfactory corporate conduct has occurred and allows them to better assess the quality and performance of management makes no sense, said the court, when the shareholders, having been blatantly lied to in connection with the multi-billion-dollar purchase of a huge, nearly-bankrupt company, need to lose another $33 million of their money in order to better assess the quality and performance of management.

The SEC said that it could not employ its normal policy of going after the company executives who were responsible for the lie because the evidence was that lawyers for Bank of America and Merrill drafted the documents at issue and made the relevant decisions concerning disclosure of the bonuses. But if that is the case, said the court, why are the penalties not then sought from the lawyers and why does that justify imposing penalties on the shareholder victims.

Indeed, said the court, a careful reading of the parties’ submissions leaves the distinct impression that the proposed consent judgment was a contrivance designed to provide the SEC with the facade of enforcement and the management of the bank with a quick resolution of an embarrassing inquiry; all at the expense of the sole alleged victims, the shareholders. Even under the most deferential review, said the court, the proposed consent judgment could not remotely be called fair.

Further, the court found that a proposal asking the victims to pay a fine for their having been victimized is as unreasonable as it is unfair. It is also unfair because it would effectively close the case without the SEC adequately accounting for why it did not pursue charges against either bank management or the lawyers who allegedly were responsible for the false proxy statements. The SEC says this is because charges against individuals for making false proxy statements require, at a minimum, proof that they participated in the making of the false statements knowing the statements were false or recklessly disregarding the high probability the statements were false.

But how can such knowledge be lacking, asked the court, when the complaint in effect alleges that bank executives expressly approved Merrill’s making year-end bonuses before they issued the proxy statement denying such approval. The SEC states that culpable intent was nonetheless lacking because the lawyers made all the relevant decisions. But if that is so, asked the court, how can the lawyers be said to lack intent.

In its reply brief, the SEC maintained that there was insufficient evidence to establish a prima facie case of the requisite scienter with respect to the lawyers for purposes of alleging secondary liability under the securities laws. Further, the Commission said that BofA’s counsel could not be charged with primary violations of the federal proxy provisions because they did not solicit the proxies in their name

The SEC also claimed that it was stymied in determining individual liability because the bank’s executives said the lawyers made all the decisions but the bank refused to waive attorney-client privilege. But it appears, noted the court, that the SEC. never seriously pursued whether this constituted a waiver of the privilege, let alone whether it fit within the crime/fraud exception to the privilege. And even on its face, continued the court, such testimony would seem to invite investigating the lawyers.

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